Lindsey Wicks explains the changes to the R&D tax schemes that come into force from April 2023 and beyond.
Research and development (R&D) tax relief was introduced in 2000 to encourage companies to spend more on R&D. In the period from 1981 to 1999, expenditure on R&D in the UK fell as a proportion of GDP, while in most comparable countries it was rising. Has R&D tax relief achieved its aim of encouraging greater expenditure on R&D?
The statistics in our charts (above and below) show both a growing number and value of R&D claims. This is for both R&D tax regimes: the regime for small and medium-sized enterprises (SMEs) and the R&D expenditure credit (RDEC). Surely the reliefs are a success?
Although the reliefs were worth 0.25% of GDP in 2018 compared with an OECD average of 0.1% of GDP, UK business investment in R&D remains significantly lower than the OECD average. The latest evaluations published by HMRC show that while the RDEC scheme generates £2.40-£2.70 of additional R&D expenditure for each £1 of tax relief claimed, the SME scheme generates just £0.60-£1.28. At the same time, the SME scheme costs the government more than RDEC. The SME scheme has also grown at a faster rate than RDEC, and the R&D reliefs are forecast to continue growing. In its October 2021 Economic and Fiscal Outlook, the Office for Budget Responsibility predicted that the cost of the reliefs will increase from £7.7bn in 2021/22 to £11.9bn in 2026/27, unless modifications to the regimes are made.
Despite the number of claims by SMEs being higher, the value of claims by large companies was higher historically. RDEC has boosted both the number and value of claims by large companies.
A PAYE and NIC cap was reintroduced for SME credits from 1 April 2021. In May 2022, HMRC placed some R&D claims on pause while it investigated irregularities and introduced extra compliance checks in June.
Changes to R&D tax relief from April 2023 have been trailed since the Autumn Budget 2021. However, the Autumn Statement 2022 made a more surprising announcement: namely that the rates of relief will change quite significantly for expenditure incurred on or after 1 April 2023. To quote the Autumn Statement, this “is a step towards a simplified, single RDEC-like scheme for all”.
Editor’s note: On Friday 13 January 2023, HM Treasury launched an eight-week consultation on the design of a single, simplified R&D tax relief scheme, merging the existing RDEC and SME R&D relief. If implemented, the new scheme is expected to be in place from 1 April 2024. Read the consultation.
A reminder of how the reliefs work
SMEs can currently claim an additional deduction equal to 130% of their qualifying expenditure. This means that for every £1 spent on qualifying R&D, they get tax relief of 43.7p (£1 x 230% x 19%).
Recognising that loss-making SMEs – particularly start-ups – may not be able to carry back losses to obtain the benefit of the tax relief, they can claim a payable credit instead. However, the credit rate is set at 14.5%, lower than the corporation tax rate. The benefit for every £1 spent on qualifying R&D is therefore 33.35p (£1 x 230% x 14.5%). The amount that can be surrendered for a credit is the lower of the amount of the unrelieved trading loss sustained in that period and 230% of the related qualifying R&D expenditure.
Since 1 April 2021, the SME credit is capped if certain conditions are not met. The cap is £20,000 plus 300% of the company’s relevant expenditure on workers for payment periods that end in the accounting period.
RDEC is calculated differently. In addition to obtaining 19p tax relief for every £1 of qualifying expenditure, companies can claim a taxable credit, calculated as a percentage of the qualifying expenditure for the relevant accounting period. The current headline rate is 13%, equating to 10.53p per £1 of qualifying expenditure after tax. The credit is also payable, subject to various restrictions and set offs.
For expenditure on or after 1 April 2023, the RDEC rate increases from 13% to 20%, the SME additional deduction will decrease from 130% to 86%, and the SME credit rate will decrease from 14.5% to 10%.
Companies that do not have a 31 March year end will need to apportion their qualifying R&D expenditure for periods that straddle 1 April 2023 to ensure that the correct rates are applied
The changes to the R&D rates coincide with changes to the corporation tax rate. For simplicity, the table below assumes a corporation tax rate of 19% in the period to 31 March 2023 and 25% thereafter. However, from 1 April 2023, the small profits rate of 19% and marginal relief will apply to some companies.
In broad terms, the headline benefits for the SME and RDEC schemes are as follows:
Companies that do not have a 31 March year end will need to apportion their qualifying R&D expenditure for periods that straddle 1 April 2023 to ensure that the correct rates are applied.
Other changes that companies should prepare for
Autumn Budget 2021 announced various other changes to the R&D schemes. The timing from when these changes apply is slightly different – they apply to claims made in respect of accounting periods beginning on or after 1 April 2023. Therefore, a company with a 31 December year end would first apply these rules for the accounting period beginning 1 January 2024.
The timing from when the Autumn Budget 2021 changes apply is slightly different – they apply to claims made in respect of accounting periods beginning on or after 1 April 2023
In summary, the changes will:
- expand the categories of qualifying expenditure to include data licences and cloud computing costs;
- focus the reliefs on UK expenditure, by limiting the reliefs to UK expenditure or qualifying overseas expenditure;
- require claimants to submit a pre-notification of their claim, if they are new claimants or have not claimed in the previous three accounting periods; and
- require the provision of additional information to support claims.
A simplified, single RDEC-like scheme
Aside from the differences in rates and calculations between the SME scheme and RDEC, there are also divergences between what expenditure can qualify for relief.
Under the SME scheme, it is possible to include up to 65% of subcontractor costs where the subcontractor is not connected to the company. By contrast, the RDEC has strict restrictions on what subcontractor costs can be included in a claim (generally restricted to charity or scientific research organisation costs). Note the interplay with the restriction to UK expenditure or qualifying overseas expenditure for accounting periods beginning on or after 1 April 2023.
One of the advantages of RDEC is that companies can make a claim even if the expenditure is subsidised. It is not possible to make a claim for subsidised expenditure under the SME regime. That is why some SMEs make RDEC claims. Randeep Dhaliwal, a Senior Tax Manager at Kreston Reeves and a member of ICAEW’s Business Tax committee, explained the current difference of opinion between HMRC and the profession on what constitutes subsidised expenditure in the June 2022 issue of TAXline.
Another driver for change might be the 15% minimum rate of tax that will apply for accounting periods beginning on or after 31 December 2023. These rules will require large groups, including those operating exclusively in the UK, to pay a top-up tax where their operations have an effective tax rate of less than 15%. The consultation on reforming audio-visual tax reliefs launched at the Autumn Statement 2022 proposes moving to an expenditure credit model as expenditure credits arguably do not lower the effective tax rate.
Lindsey Wicks, Technical Editor, ICAEW
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